What is a conventional loan?
The term "conventional loan" can be used to describe any mortgage loan that is not backed by a government agency. Instead, most conventional loans are held to the guidelines set by the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac). However, there are also conventional loans that fall outside of those guidelines as well.
Typically, a conventional loan program will give the borrower more flexibility than a similar government-backed loan. In particular, these loans often come with a lower interest rate and a higher loan limit than other types of financing. However, in exchange for that flexibility, they often come with stricter qualifying requirements.
How is conventional financing different from a government loan?
Now that you have a better idea of what a conventional home loan is and how it works, it's a good idea to clarify how it differs from a government loan. In light of that, we've listed out some of the differences below.
Backed by the Federal Housing Administration (FHA), these loans have lower credit score requirements than a conventional loan. FHA borrowers can get a loan with a credit score of 500, as long as they are able to put 10% down. However, if they have a credit score of at least 580, they can secure a home loan for as little as 3.5% down.
Meanwhile, the minimum credit score required to get a conventional loan is 620, which makes an FHA loan a good option if your score is on the lower end.
On the other hand, each VA loan is backed by the Department of Veterans Affairs (VA). While these loans are reserved for military members and their spouses, they offer some unique benefits if you qualify. In particular, these loans do not have a down payment requirement, a minimum credit score requirement, or a private mortgage insurance (PMI) requirement.
Lastly, a USDA loan is backed by the U.S. Department of Agriculture (USDA). These loans are meant for low-to-moderate-income borrowers who are looking to live in rural areas. They are unique in that they allow for up to 100% financing of the home's purchase price, and they allow for a lower credit score.
What are the different types of conventional loans?
While a government-backed loan can offer some unique benefits for those who need them, if you can qualify for a conventional loan, you can likely secure a lower interest rate, which will save you money on your monthly payment and over the life of the loan. Let's take a closer look at the different types of conventional financing that are available to you:
- Conforming loan: The majority of conventional loans are conforming loans. A conforming loan is a loan that falls within the conforming loan limits for the year. In 2021, the conforming loan limit is $548,250. However, it is worth noting that the loan limit extends to $822,375 in certain high-cost areas. In addition, they also meet the other borrowing guidelines set forth by Fannie Mae and Freddie Mac.
- Nonconforming loan: In contrast, a nonconforming loan does not meet the guidelines set by Fannie Mae and Freddie Mac. For instance, it could be a jumbo loan, which falls outside the conforming loan limit for a given year. Alternatively, it could be a portfolio loan, where the qualifying requirements are set by a private lender instead of the two government-sponsored enterprises (GSEs).
- Fixed-rate loan: Most of the time, a conventional mortgage is also a fixed-rate loan, which means that the interest rate stays the same over the life of the loan. As a homebuyer, the big advantage of this loan option is that you have a stable monthly payment.
- Adjustable-rate mortgage: On the other hand, with an adjustable-rate mortgage, the mortgage rate can vary according to current market rates. While this type of loan can help you save money when interest rates are low, it's important to understand that your payment can rise over time.
The bottom line
At the end of the day, as long as you have a credit score of at least 620, a lower debt-to-income ratio, and a stable source of income, there's a good chance that you will be able to qualify for a conventional loan program. However, if you have questions regarding your specific financial situation, it's a good idea to get in touch with a mortgage lender. They can give you a better sense of whether a conventional mortgage loan is a right fit for you.